U.S. patent number 8,180,695 [Application Number 12/209,603] was granted by the patent office on 2012-05-15 for method of administering an investment fund that seeks to provide regular monthly payments without consuming principal.
This patent grant is currently assigned to The Vanguard Group, Inc.. Invention is credited to John Ameriks, John Buhl, Edward Delk, Kathryn Hyatt, Ranga Narayanan, Shawn Travis, Daniel Wallick.
United States Patent |
8,180,695 |
Ameriks , et al. |
May 15, 2012 |
Method of administering an investment fund that seeks to provide
regular monthly payments without consuming principal
Abstract
A method of administering an investment fund. The method
includes the steps of creating shares for sale, providing a managed
distribution schedule identifying a number of payments to be
provided during each of consecutive periods, providing an
investment strategy for investing in assets to provide funds
sufficient to meet the managed distribution schedule, issuing a
share to an investor in exchange for funds received from the
investor, investing the received funds according to the investment
strategy, calculating the value of each of the payments to be
provided according to the managed distribution schedule in a period
to the investor, and providing each of the payments to the investor
during the period. Each payment is calculated according to a
formula that specifies that the value of each payment is based on a
trailing Net Asset Value (NAV) of the investor's share.
Inventors: |
Ameriks; John (Malvern, PA),
Buhl; John (Wayne, PA), Delk; Edward (Paoli, PA),
Hyatt; Kathryn (Wayne, PA), Narayanan; Ranga (Exton,
PA), Travis; Shawn (Wayne, PA), Wallick; Daniel
(Haverford, PA) |
Assignee: |
The Vanguard Group, Inc.
(Valley Forge, PA)
|
Family
ID: |
40452505 |
Appl.
No.: |
12/209,603 |
Filed: |
September 12, 2008 |
Prior Publication Data
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Document
Identifier |
Publication Date |
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US 20090076980 A1 |
Mar 19, 2009 |
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Related U.S. Patent Documents
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Application
Number |
Filing Date |
Patent Number |
Issue Date |
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60993746 |
Sep 14, 2007 |
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Current U.S.
Class: |
705/36R;
705/35 |
Current CPC
Class: |
G06Q
40/04 (20130101); G06Q 40/10 (20130101); G06Q
40/06 (20130101); G06Q 40/12 (20131203); G06Q
40/00 (20130101) |
Current International
Class: |
G06Q
40/00 (20060101) |
Field of
Search: |
;705/36R,37 |
References Cited
[Referenced By]
U.S. Patent Documents
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Primary Examiner: Maguire; Lindsay M
Assistant Examiner: Kwong; Cho
Attorney, Agent or Firm: RatnerPrestia
Parent Case Text
CROSS REFERENCE TO RELATED APPLICATIONS
This application claims priority from U.S. Provisional Application
No. 60/993,746, filed Sep. 14, 2007, the contents of which are
herein incorporated by reference in their entirety for all
purposes.
Claims
What is claimed is:
1. A method of administering an investment fund, the method
comprising: creating a plurality of shares in the investment fund
for sale; providing a managed distribution schedule comprising a
plurality of consecutive annual periods, a number of payments to be
provided during each of the consecutive annual periods, and a
formula for calculating a value for each of the payments, the value
comprising 1/n.sup.th of a predetermined percentage of a designated
value corresponding to one of the plurality of shares, wherein n
equals a number of payments, and the designated value for at least
one of the consecutive annual periods comprises a trailing Net
Asset Value (NAV); providing an investment strategy for investing
in assets to provide funds sufficient to meet the managed
distribution schedule, including selecting an asset allocation
strategy chosen from an efficient frontier of modeled asset
allocation strategies plotted by probability of year-to-year
decline and probability of maintaining real or nominal
distributions, the assets composing an investment portfolio;
issuing at least one share to an investor in exchange for funds
received from the investor; investing the received funds according
to the investment strategy; calculating annually, by a computer
programmed to perform such calculations, the value of each of the
payments to be provided according to the managed distribution
schedule in a period; and providing each of the payments to the
investor during the period.
2. The method of claim 1, wherein the trailing NAV is calculated by
averaging NAV over a predetermined amount of time.
3. The method of claim 1, wherein the investment strategy is
designed to preserve a value of the assets, as a whole, on a real
or nominal basis.
4. The method of claim 1, wherein the investment strategy is
designed to achieve a long-term performance target.
5. The method of claim 1, wherein each of the periods comprises a
year and n=12.
6. The method of claim 5, wherein: for a first year of the
investment fund, the designated value comprises an initial
per-share value, and for a second year and subsequent years of the
investment fund, the designated value comprises a trailing NAV
calculated using an averaged daily per-share NAV over at least a
portion of years of the investment fund prior to the second or
subsequent years.
7. The method of claim 6, wherein for a third year of the
investment fund, the designated value comprises an averaged daily
per-share NAV over at least a portion of the first and second years
of the investment fund.
8. The method of claim 6, wherein for a fourth year or subsequent
years of the investment fund, the designated value comprises an
averaged daily per-share NAV over at least a portion of three years
of the investment fund previous to the fourth or subsequent
years.
9. The method of claim 1, further comprising: periodically
modeling, by a computer programmed to perform such modeling,
historical results of asset classes and investments represented in
the investment portfolio and asset classes and investments not
represented in the investment portfolio; adjusting the asset
allocation strategy of the investment portfolio to a revised group
of asset classes and investments; and reinvesting or rebalancing
the investment portfolio according to the adjusted asset allocation
strategy.
Description
BACKGROUND OF THE INVENTION
Many investors arrive at retirement with substantial assets
accumulated over years of disciplined saving and prudent investing.
Often, these investors are concerned about how best to use their
assets to meet monthly retirement expenses, while at the same time
preserving their assets for heirs, philanthropy, or other purposes.
Traditionally, these investors have had three basic options for
generating retirement income:
1. A "planned withdrawal program," in which an investor gradually
spends a limited portion of assets over a set period, with the
remaining assets invested for long-term retirement goals.
2. A "guaranteed income option," in which an investor turns over
assets to an insurance company and purchases a fixed immediate
annuity that provides guaranteed income for life.
3. A "spend only the income strategy," in which an investor spends
only the dividend and interest income generated by his or her
retirement portfolio, leaving the principal intact.
SUMMARY OF THE INVENTION
According to one aspect, the present invention includes an
embodiment of a method of administering an investment fund. The
method includes the steps of creating a plurality of shares in the
investment fund for sale, providing a managed distribution schedule
identifying a number of payments to be provided during each of a
plurality of consecutive periods, providing an investment strategy
for investing in assets to provide funds sufficient to meet the
managed distribution schedule, issuing at least one share to an
investor in exchange for funds received from the investor,
investing the received funds according to the investment strategy,
calculating the value of each of the payments to be provided
according to the managed distribution schedule in a period, and
providing each of the payments to the investor during the period.
The managed distribution schedule includes a formula for
calculating a value for each of the payments in the period. The
formula specifies that the value of each payment equals 1/nth of a
predetermined percentage of a designated value corresponding to one
of the plurality of shares. The number, n, equals a number of
payments to be made in the period, and the designated value equal a
trailing Net Asset Value (NAV).
According to another aspect, the present invention includes another
embodiment of a method of administering an investment fund. In this
other embodiment, the method includes the steps of creating a
plurality of shares in the investment fund for sale, providing a
managed distribution schedule identifying a number of payments to
be provided during each of a plurality of consecutive periods,
issuing at least one share to an investor in exchange for funds
received from the investor, investing the received funds in assets
including cash, securities, derivatives and other investments, and
providing payments to the investor in a period according to the
managed distribution schedule. The managed distribution schedule
includes a formula for calculating a value for each of the
payments. The formula specifies that the value for each payment in
the period equals 1/nth of a predetermined percentage of a
designated value corresponding to one of the plurality of shares.
The number, n, equals a number of payments to be made in the
period, and the designated value equals a trailing Net Asset Value
(NAV).
BRIEF DESCRIPTION OF THE FIGURES
The invention is understood from the following detailed description
when read in connection with the following figures:
FIG. 1 illustrates an investment fund comprising an investment
portfolio, in accordance with an embodiment of the present
invention;
FIG. 2 illustrates a flow diagram of a method of constructing and
managing the fund illustrated in FIG. 1, in accordance with an
embodiment of the present invention;
FIG. 3 illustrates a flow diagram of a method of constructing and
managing an investment portfolio of the fund illustrated in FIG. 1,
in accordance with an embodiment of the present invention;
FIG. 4 illustrates an exemplary plot of the probabilities of
various investment funds of maintaining real spending power after
20 years versus the probabilities of payments made by such funds
declining by 5% from one year to the next, in accordance with an
embodiment of the present invention;
FIG. 5 illustrates a capital markets model employed by the method
illustrated in FIG. 3, in accordance with an embodiment of the
present invention; and
FIG. 6 illustrates exemplary distributions of outcomes generated by
simulations of the capital markets model illustrated in FIG. 5 for
selected asset classes, in accordance with an exemplary embodiment
of the present invention.
DETAILED DESCRIPTION OF THE INVENTION
Retirees generally have two basic needs in retirement funds: (1)
regular monthly payments to help meet retirement expenses, and (2)
the preservation of retirement savings for future use.
Referring now to FIG. 1, there is illustrated an investment fund
100 comprising an investment portfolio 110 and a plurality of
shares 120. Portfolio 110 comprises a plurality of securities and
other investments (collectively referred to herein as
"securities"). The securities may comprise any of stocks (e.g.,
U.S. stocks or foreign stocks, such as emerging-market stocks),
bonds, commodity futures, inflation-indexed securities (e.g.,
Treasury Inflation Protected Securities ("TIPS")), shares in real
estate investment trusts ("REITs"), hybrid securities, currencies,
options on securities or securities indexes, futures contracts,
options on futures contracts, credit default swaps, total return
swaps, forward foreign currency agreements and other derivatives.
The securities in portfolio 110 may further comprise shares in one
or more funds, such as stock funds, funds that track the Europe,
Australasia, and Far East ("EAFE") Index, funds that track the
Lehman Aggregate Bond Index, commodities funds, money market funds,
equity market neutral funds, absolute return funds, etc. In
embodiments of fund 100 where portfolio 110 includes shares in one
or more investment funds, fund 100 may be described as a "fund of
funds." It is understood that the descriptor, "fund of funds,"
however, does not exclude fund 100 from owning other types of
securities directly. Thus, fund 100 may be characterized as a "fund
of funds" even while owning stock, bonds, futures, etc. directly in
portfolio 110.
In the embodiment of fund 100 illustrated in FIG. 1, portfolio 110
includes one or more U.S. stocks, one or more emerging market
stocks, one or more shares in one or more EAFE Index funds, one or
more shares in one or more Lehman Aggregate Bond Index funds, cash,
one or more TIPS, one or more shares in one or more REITs, one or
more commodity-linked instruments, one or more shares in one or
more equity market neutral funds, and one or more shares in one or
more absolute return funds. Fund 100 is formed and managed by a
fund administrator (not illustrated).
Referring now to FIG. 2, there is illustrated a method 200 for
constructing and managing fund 100 and providing payments to
shareholders, in accordance with an exemplary embodiment of the
present invention. Method 200 begins with a step 210 of
establishing a managed distribution policy of fund 100 at the
inception for fund 100. More specifically, in step 210, fund 100,
or more specifically the administrator of fund 100, establishes a
managed distribution policy (also called a "payment schedule") to
determine how payments of fund 100 are to be calculated, sourced
and distributed to shareholders in fund 100 over the life of fund
100. Method 200 continues to a step 220 in which the administrator
of fund 100 establishes investment objectives, investment
strategies and performance targets for fund 100 to allow fund 100
to achieve its managed distribution policy.
The investment objectives, investment strategies, performance
targets, and the managed distribution policy of fund 100 determine
how fund 100 is structured and managed. Generally, the
administrator chooses the investment objectives, investment
strategies, performance targets, and managed distribution policy to
allow fund 100 to operate to the extent possible without consuming
capital.
Several exemplary embodiments of fund 100 are described herein. In
each of the several embodiments of fund 100, the specifics of the
investment objectives, investment strategies, performance targets,
and managed distribution policies differ as follows:
In a first embodiment of fund 100 (herein "Fund A"), the
administrator of fund 100 seeks to generate total returns
sufficient to sustain a managed distribution policy while providing
inflation protection and capital appreciation over the long term.
The managed distribution policy of Fund A is based on an annual
distribution rate equal to 3%. Thus, the investment objective of
Fund A is to seek to make monthly distributions of cash while
providing inflation protection and capital appreciation over the
long term, and the investment strategy is tailored to achieve this
investment objective.
In a second embodiment of fund 100 (herein "Fund B"), the
administrator of fund 100 seeks to generate total returns
sufficient to sustain a managed distribution policy while providing
inflation protection and capital preservation over the long term.
The managed distribution policy of Fund B is based on an annual
distribution rate equal to 5%. Thus, the investment objective of
Fund B is to seek to make monthly distributions of cash while
providing inflation protection and capital preservation over the
long term, and the investment strategy is tailored to achieve this
investment objective.
In a third embodiment of fund 100 (herein "Fund C"), the
administrator of fund 100 seeks to generate total returns
sufficient to sustain a managed distribution policy while
preserving capital over the long term. The managed distribution
policy of Fund C is based on an annual distribution rate equal to
7%. Thus, the investment objective of Fund C is to seek to make
monthly distributions of cash while providing capital preservation
over the long term, and the investment strategy is tailored to
achieve this investment objective.
Although method 200 indicates the flow of the method progressing
from step 210 to step 220 (the flow being indicated by the arrow
extending from step 210 to step 220), it is contemplated that steps
210 and 220 may be performed in any order. Thus, the administrator
of fund 100 may establish a managed distribution policy for fund
100 at its inception in step 210 and then develop investment
objectives, investment strategies and performance targets for fund
100 in step 220 to satisfy the managed distribution policy, or the
administrator of fund 100 may establish investment objectives,
investment strategies and performance targets for fund 100 in step
220 and then develop a managed distribution policy in step 210 to
make distributions resulting from the investments of fund 100.
Furthermore, although method 200 indicates that the investment
objectives, investment strategies and performance targets are
developed in one step (step 220), it is contemplated that the
investment objectives, investment strategies and performance
targets may each be developed in separate sub-steps.
The Managed Distribution Policy of Fund 100
The managed distribution policy of fund 100 generally provides for
the periodic distribution of a targeted amount of cash (payments)
to be made to shareholders during each of a plurality of
consecutive periods based on (1) a distribution rate specified in
the managed distribution policy of fund 100 and (2) prior
performance of fund 100. The managed distribution policy provides
for a number of payments to be provided during each of the
consecutive periods and contemplates that the payments are fixed
and are of equal amounts in each of the periods, unless there are
one or more additional distributions made sometime during a period.
As described below, the distributions per share vary from
period-to-period based on the prior performance of fund 100.
The managed distribution policy sets forth rules for calculating
the payments to be made in each of the consecutive periods for each
share 120 of fund 100. More specifically, the managed distribution
policy specifies a formula that determines how dollar amounts of
the payments are to be calculated in the future based on the
distribution rate and the prior performance of fund 100 and how
such payments are to be distributed in the future. Due to market
volatility, fund 100 does not specify, at the inception of fund 100
or at any time thereafter, dollar amounts to be provided for the
payments in the consecutive periods. In other words, fund 100 does
not guarantee any amounts of payments to be distributed.
Payments to be provided during each of the consecutive periods in
the future are to be calculated during each of the consecutive
periods or in a period immediately preceding each of the
consecutive periods. In one exemplary embodiment, the calculations
during the consecutive periods are to be completed at the
beginnings of the consecutive periods.
In an exemplary embodiment of the managed distribution policy, the
prior performance of fund 100 is quantified by a trailing net asset
value (herein "NAV") of each share 120 in fund 100. The trailing
NAV for each share in fund 100 is calculated by averaging the NAV
of each share in fund 100 over a predetermined period of time
preceding the time of calculation. Because the NAV is calculated
for a predetermined period of time preceding the time of
calculation, the NAV is referred to as a "trailing NAV."
In this exemplary embodiment, the managed distribution policy
provides for the calculation of per-share payments made by fund 100
to be based on the trailing NAV (in addition to the distribution
rate). More specifically, the managed distribution policy provides
that the amount of each payment to be made in each of the
consecutive periods is to be calculated to equal 1/nth of a
predetermined percentage of the trailing NAV of each share in fund
100, as represented in the following formula:
.times..times..times..times..times..times..times..times..times..times..ti-
mes..times..times. ##EQU00001## where the value "n" is to equal the
number of payments to be made in each of the consecutive periods
defined by the payment schedule and the "predetermined percentage"
is the distribution rate identified in the managed distribution
policy. The predetermined percentage (distribution rate) may, for
example, be one of 3%, 5%, or 7%, respectively corresponding to
embodiments of fund 100 as Fund A, Fund B, and Fund C.
Because the payments of fund 100 are actually calculated in the
future, i.e., at some time after the inception of fund 100, and are
based on prior performance of fund 100, e.g., the trailing NAV of
each share in fund 100, the distributions per share may vary from
one of the consecutive periods to another as the performance, e.g.,
daily NAV, of fund 100 varies over time.
In an exemplary embodiment of fund 100, each of the consecutive
periods identified by the managed distribution policy is a fiscal
year, and the managed distribution policy identifies that the
payments made during each of the fiscal years are to be made
monthly. In such an embodiment, the managed distribution policy
directs that the monthly distributions per share are to be
calculated at the beginning of each fiscal year by averaging a
per-share NAV of fund 100 over a prior three-year period of fund
100 in order to increase the relative predictability and relative
stability of the distributions of fund 100 to shareholders from
year-to-year. A modified version of the formula is to be used until
fund 100 has established three years of history. Thus, at the
beginning of the first year of fund 100, each of the monthly
payments to be provided in the first year is to be calculated using
an initial per-share value of fund 100; at the beginning of the
second year of fund 100, each of the monthly payments to be
provided in the second year is to be calculated using averaged
daily per-share NAVs of fund 100 over at least a portion of the
first year of fund 100; and at the beginning of the third year of
fund 100, each of the monthly payments to be provided in the third
year is to be calculated using averaged daily per-share NAVs of
fund 100 over at least a portion of the first and second years of
fund 100. At the beginning of the fourth year and subsequent years
of fund 100, each of the monthly payments to be provided in the
fourth and subsequent years is to be calculated using averaged
daily per-share NAVs of fund 100 over the three years previous to
the year for which the calculations are to be made.
In another exemplary embodiment of fund 100, the distributions per
share may be calculated in view of a hypothetical account of a
hypothetical shareholder of fund 100 assumed to hold shares in fund
100 purchased at inception. For purposes of the calculation of
per-share payments made by fund 100, the hypothetical account is
assumed to experience the same distributions as the accounts of
actual shareholders of fund 100 and that no further purchases or
redemptions are made for the hypothetical account except by way of
the automatic reinvestment of any and all additional distributions
in additional shares in fund 100. More specifically, in this
exemplary embodiment of fund 100, the managed distribution policy
provides that the amount of each payment to be made in each of the
consecutive periods is to be calculated to equal 1/nth of a
predetermined percentage of the average daily value of the
hypothetical account over a specified period of time, as
represented in the following formula:
.times..times..times..times..times..times..times..times..times..times..ti-
mes..times..times..times..times..times..times..times..times..times..times.
##EQU00002## where the value "n" is to equal the number of payments
to be made in each of the consecutive periods defined by the
payment schedule, the "predetermined percentage" is the
distribution rate identified in the managed distribution policy,
and the value "X" is the number of shares in the hypothetical
account. The predetermined percentage may be one of 3%, 5%, or 7%,
respectively corresponding to embodiments of fund 100 as Fund A,
Fund B, and Fund C.
In a variation of the exemplary embodiment described in the
previous paragraph, each of the consecutive periods identified by
the managed distribution policy is a fiscal year, and the managed
distribution policy identifies that the payments made during each
of the fiscal years are to be made monthly. In this variation, the
managed distribution policy directs that the monthly distributions
per share are to be calculated at the beginning of each fiscal year
by averaging the value of the hypothetical shareholder account over
a prior three-year period of fund 100 in order to increase the
relative predictability and relative stability of the distributions
of fund 100 to shareholders from year-to-year. A modified version
of the formula is to be used until fund 100 has established three
fiscal years of history. Thus, in the first fiscal year of the
fund, the monthly per-share distribution is based on the initial
account balance of the hypothetical shareholder; in the second
fiscal year, the average daily account balance of the hypothetical
shareholder over the first fiscal year (or the portion of the first
fiscal year for which the fund was in existence) is used to
determine the monthly distribution per share; and in the third
fiscal year, the average daily account balance of the hypothetical
shareholder over the first two fiscal years is used to determine
the monthly distribution per share. Finally, in the fourth and
subsequent fiscal years, the average daily account balance of the
hypothetical shareholder over a prior three-fiscal-year time period
will be used to determine the monthly distribution per share.
In a variation of the exemplary embodiments of fund 100 discussed
above in which the managed distribution policy sets forth monthly
payments to be made over a plurality of consecutive fiscal years,
the managed distribution policy calls for the distribution of a
targeted amount of cash to be provided to the shareholders of fund
100 on or about the 15th calendar day of each month in a calendar
year. The monthly distribution per share for fund 100 in a given
calendar year is calculated as of January 1 of that year. The
managed distribution policy contemplates that the payments to be
provided during a calendar year are fixed during that year, unless
there are one or more additional distributions with respect to the
same calendar year of fund 100, which would be coincident to the
calendar year. The monthly distributions per share for any calendar
year, however, are still expected to vary from year-to-year based
on the performance of fund 100 during prior years.
Finally, it should again be emphasized that the distribution rates
(predetermined percentages) of Funds A, B, and C differ and,
therefore, their managed distribution policies differ. The managed
distribution policies of Funds A, B, and C specify monthly payments
that are to be provided during consecutive calendar years. The
monthly payments of Fund A are calculated to equal 1/12th of 3% of
the trailing NAV of each share in fund 100 at the time of
calculation; the monthly payments of Fund B are calculated to equal
1/12th of 5% of the trailing NAV of each share in fund 100 at the
time of calculation; and the monthly payments of Fund C are
calculated to equal 1/12th of 7% of the trailing NAV of each share
in fund 100 at the time of calculation.
Developing an Investment Portfolio and Managing Fund 100
Continuing with the description of method 200, after establishing
the managed distribution policies, investment objectives,
investment strategies and performance targets in steps 210-220,
processing continues to a step 230 in which the administrator of
fund 100 develops investment portfolio 110 based on quantitative
analysis and professional judgment, and then continues to a step
240 in which the administrator manages fund 100 and particularly
portfolio 110.
Generally, in step 230, the administrator of fund 100 (1)
identifies eligible asset classes and investments for fund 100, (2)
establishes strategic asset allocation ranges specifying minimum
and maximum long-term allocations to eligible asset classes and
investments of fund 100 and (3) establishes a short-to-intermediate
term asset allocation target for fund 100. The administrator's
asset allocation target governs the administrator's day-to-day
investment decisions for fund 100 made in step 240.
In step 230, to identify eligible asset classes, the administrator
uses quantitative analysis and professional judgment in an attempt
to combine complementary asset classes across the risk/reward
spectrum. The administrator may combine complementary asset classes
with historical correlations to one another that are less than a
predetermined threshold set by the administrator in order to
generate positive long-term total returns through economic and
market conditions with a level of risk less than a threshold
determined by the administrator. While managing fund 100 in step
240, the administrator need not maintain a fixed asset allocation
policy for fund 100 (although the administrator may adopt such a
policy), and the exact proportion of each asset class or investment
may be changed to reflect shifts in the administrator's risk and
return expectations. In other words, while managing fund 100 in
step 240, the administrator is not tied to an asset allocation
policy developed in step 230. In summary, the administrator's goal
for fund 100 is to construct a broadly diversified portfolio that
achieves the investment objective of fund 100.
Method 200 continues to a step 250 in which payments are calculated
for each of the periods of fund 100 and provided to shareholders of
fund 100 according to the managed distribution policy. As time
progresses and after payments are made, further adjustments to the
asset allocations of portfolio 110 may be required. Thus, method
200 may loop back from step 250 to step 240 where the administrator
may further manage fund 100. Method 200 continues as described
above.
Referring now to FIG. 3, there is illustrated an exemplary method
300 for constructing and managing investment portfolio 110 of fund
100, in accordance with an exemplary embodiment of the present
invention. Method 300 illustrates steps 210-240 of method 200 in
more detail.
Generally, to produce an investment portfolio that has a relatively
low probability of year-to-year decline and/or a relatively high
probability of maintaining real (rather than nominal)
distributions, developing an asset allocation strategy involves
dynamically allocating assets across a broadly diversified
selection of investment opportunities. The administrator uses
quantitative analysis and professional judgment in an attempt to
combine complementary asset classes and investments across the
risk/reward spectrum. The goal is to construct a broadly
diversified portfolio that achieves the investment objective of
fund 100. The multi-asset investment strategy of fund 100 is more
likely to achieve the investment objective of fund 100 than would a
conventional fixed allocation among stocks, bonds, and cash. As
noted above, fund 100 may choose from any of the following types of
assets or investments (or others): stocks, bonds, cash, money
market investments, long/short market neutral investments, absolute
return investments, commodity-linked investments, inflation-linked
investments, and real estate investments. The administrator of fund
100 constructs the asset allocation strategy to determine the
proportions of asset classes and investments that reflect the
administrator's evaluation of their expected returns and risks as
an integrated whole.
As noted above, fund 100 may invest in both traditional assets
(such as stocks, bonds, and money market funds) and non-traditional
investments (such as absolute return strategies and alternative
asset classes, like commodities). The selection and weighting of
asset classes and investments is determined by the asset allocation
strategy of fund 100 constructed using method 300. It is
contemplated that asset allocation strategies are flexible.
Initially, fund 100 may obtain equity and fixed income exposure
through index funds, generate long/short market neutral returns
through specialized funds designed for this purpose and generally
characterized as equity market neutral funds, make absolute return
investments directly or through various financial arrangements
including shares in a specialized fund designed for this purpose,
and gain exposure to the returns of a broad-based selection of
commodity futures through futures contracts, commodity-linked swap
agreements, commodity-linked structured notes or other
commodity-linked derivatives. The asset allocation strategy of fund
100 may change over the life of fund 100 to alter these
exposures.
Method 300 begins with a step 310 of generating models of asset
classes based on historical investment and macroeconomic behavior.
More specifically, step 310 provides historical data for asset
classes and outputs the data, which data includes asset class and
investment return averages, volatility, and correlations between
the modeled asset classes and investments. In a step 320, the
administrator reviews these outputted data and makes any
adjustments as necessary to the models of the asset classes. In a
step 330, projections of the modeled assets classes and investments
are generated to estimate future performance of the asset classes
and investments.
Processing continues to a step 340 in which method 300 receives
various inputs from the administrator of fund 100. Step 340
comprises sub-steps 340A, 340B, and 340C. In sub-step 340A, the
administrator specifies an exact payout pattern or spending
strategy for fund 100. An example of an exact payout pattern or
spending strategy is the managed distribution policy discussed
above. In an exemplary embodiment, for the limited purpose of
selecting candidate investment portfolios, the distributions of
fund 100 under its managed distribution policy and each of the
candidate investment portfolios are assumed, in sub-step 340A, (1)
to be paid in four equal installments at the end of each quarter of
each year, and (2) to sum to 5% of the average balance at the end
of the most recent twelve quarters, with the initial year's
payments totaling 5% of the initial purchase.
In sub-step 340B, the administrator determines candidate portfolios
of investments and/or asset allocation strategies to be modeled, as
well as any hard constraints on the investment allocations for
portfolio 110. The administrator selects viable candidate
portfolios based on a consideration of a wide range of strategic
inputs, which may include some combination of the following factors
(or others): the prior performance of fund 100; value at risk and
expected shortfall; volatility; macroeconomic factors; current and
expected market conditions; cash flows; estimates of changes in the
spreads between the expected returns of eligible asset classes and
investments; historical and expected correlations between and among
asset classes and investments; quantitative modeling of the
likelihood that a proposed combination of assets and investments
will achieve the investment objective of fund 100; and the results
of stress tests.
Finally, in sub-step 340C, the administrator determines the
quantitative objectives to be optimized for candidate portfolios
for consideration for selection as portfolio 110 of fund 100.
Examples of quantitative objectives that the administrator may
specify in sub-step 340C include: median simulated real geometric
mean return over 30 years, median simulated real geometric mean
growth in simulated distributions over 30 years, median simulated
nominal geometric mean growth in simulated distributions over 30
years, median simulated real geometric mean growth in simulated
distributions over 30 years, estimated probability of a 5%
year-to-year decline in simulated nominal payments, estimated
probability of 3 consecutive years of a 5% or more decline in
simulated nominal payments over a 30-year history, estimated
probability of maintaining nominal value of simulated nominal
payments over a set period, and estimated probability of
maintaining real value of simulated nominal payments over a set
period.
Continuing with the description of method 300, in a step 350, the
administrator uses a simulation to identify candidates for
portfolio 110. Particularly, the simulation uses the data supplied
by the administrator in sub-steps 340A-C and the results provided
by step 330 to optimize construction of portfolio 110 across
multiple asset classes and investments. In an exemplary embodiment,
the simulation is a regression-based Monte Carlo simulation that
runs a large number of cycles on each possible portfolio, with each
run simulating long-term future performance. While particular types
of simulations may be considered superior to others and the overall
performance of fund 100 may be highly dependent on the robustness
of the simulation performed, the present invention is not limited
to or dependent upon the use of any particular type of simulation.
The results, i.e., the modeled portfolios and asset allocations, of
the capital markets simulation model are outputted and plotted in a
step 360.
Referring now to FIG. 4, there are illustrated exemplary results
plotted in step 360, which results are provided by the simulation
performed in step 350. Each portfolio is plotted by its probability
of maintaining real spending power after 20 years and its
probability of a 5% decline in payments from one year to the next.
Optimal portfolios lie along the upper frontier of plot 400, as
they have the greatest probability of maintaining real spending
power after 20 years given a particular probability of a 5% decline
from one year to the next. Although not illustrated, it is also
contemplated that plot 400 may plot probability of maintaining
nominal spending power after 20 years rather than real spending
power.
Continuing again in method 300 illustrated in FIG. 3, after the
results of the capital markets simulation model are plotted in step
360, processing continues to a step 370. In step 370, the
administrator chooses an investment portfolio from the modeled
results plotted by probability of year-to-year decline versus
probability of maintaining real distributions greater than a
predetermined probability. The administrator therefore selects an
investment portfolio from the upper "efficient" frontier of plot
400, from candidate investment portfolios having a relatively low
probability of year-to-year decline and/or a relatively high
probability of maintaining real distributions. Embodiments in which
the administrator considers probabilities of maintaining nominal
spending power rather than real spending power are also
contemplated.
Finally, in step 380, the advisor seeks to manage fund 100
consistent with a variety of statistical and compliance-based risk
management controls and procedures. As the administrator manages
fund 100 according to the calculated asset allocation strategy in
step 380, the administrator of fund 100 may alter the asset
allocation strategy at any time to incorporate additional asset
classes or investments into portfolio 110 or to change the
weightings of asset classes and investments represented in
portfolio 110 in an effort to reduce overall risk or improve
risk-adjusted returns consistent with the investment objective of
fund 100. The administrator of fund 100 may use the capital markets
simulation model described above to generate revised
forward-looking asset class and investment performance expectations
for optimization of portfolio 110 at any time during the life of
fund 100. More specifically, the administrator may model a
plurality of additional candidate investment portfolios and choose
a reallocated investment portfolio from the modeled results that is
expected to have a relatively low probability of year-to-year
decline and a relatively high probability of maintaining real or
nominal distributions. Thus, the administrator may re-optimize the
asset allocation strategy of fund 100, and therefore the asset
allocation of portfolio 110 of fund 100, at any time.
The managed distribution policy of fund 100 is not supported by any
form of guarantee, line of credit, credit support or any other form
of financing intended to guarantee distributions or investment
performance to shareholders. Instead, fund 100 makes distributions
in accordance with its managed distribution policy, with the result
that distributions are likely to vary over time. Accordingly,
investors in fund 100 may see their year-to-year distributions grow
or decline roughly in tandem with average fund performance over a
trailing 3-year period (subject to the terms and conditions of the
managed distribution policies). The results of the administrator's
investment models, however, indicate that fund 100, and therefore
the accounts of the investors in fund 100, are not likely to run
out of money over time. Of course, fund 100 may experience losses,
in which case the automated payout mechanism may cause investors to
consume a corresponding portion of their principal over time. Other
embodiments of fund 100 in which fund 100 does guarantee that the
managed distributions will be met are contemplated.
As noted above, fund 100 may be embodied as one of Funds A-C. Each
of Funds A-C is targeted to appeal to a different set of investors,
although some overlap is possible. It should be noted that Funds
A-C may attract assets from outside of the retirement channel,
given the focus of Funds A-C on regular cash flows and principal
preservation.
Fund A is expected to have the greatest appeal to retirement
investors who seek only a modest current payout from their assets,
but who wish to see their payouts and capital increase over time.
Fund A is expected to sustain a managed distribution policy with a
3% annual distribution rate. Compared to the other subject funds,
Fund A has a high probability of generating growth in both capital
and payouts that exceeds inflation. If successful, Fund A should
provide long-term capital appreciation.
Fund B is likely to appeal to retirement investors who want to
balance a need for a current payout from their assets with a desire
to maintain the purchasing power of their payouts and capital over
the long term. Fund B is expected to sustain a managed distribution
policy with a 5% annual distribution rate, while providing
inflation protection and capital preservation over the long
term.
Fund C is likely to appeal to retirement investors who require a
greater payout level to satisfy current spending needs. Fund C is
expected to sustain a managed distribution policy with a 7% annual
distribution rate. Although the payouts and capital of Fund C are
not expected to grow at a rate that keeps pace with inflation, Fund
C does seek to preserve the "nominal" (or original) value of
invested capital over the long term.
Although specific embodiments are described herein comprising Fund
A, Fund B, and Fund C, it should be understood that the funds may
be offered with any incremental annual distribution rate that has a
reasonable probability of providing the targeted returns.
Furthermore, although several exemplary embodiments of fund 100 are
described above as computing payments based on the average daily
account balance of hypothetical shareholder over three calendar
years, different time periods may also be used.
As noted above, in an exemplary embodiment of method 300, the
simulation performed in step 350 is a regression-based Monte Carlo
simulation. Such an embodiment of method 300 uses the
regression-based Monte Carlo simulation to advantage over
conventional simulation tools, such as historical time-pathing and
basic Monte Carlo simulation.
Historical time-pathing consists of generating future return
scenarios based on an asset's historical returns over a chosen time
period. Since this historical analysis is restricted to the
observed historical sequence outcomes, each scenario simply starts
at a different date. A limitation with this approach is that it can
exclude extreme-tailed possibilities (rare events never recorded in
the historical data sample that could have occurred).
In basic Monte Carlo simulation, return scenarios are drawn from a
selected probability distribution of outcomes, rather than
replicating chronological segments of historical series. In
essence, an asset's simulated return at any point in time will
equal its long-term average return plus or minus "noise," the
magnitude of which is dictated by the historical volatility of the
asset. Although popular among certain investment professionals,
basic Monte Carlo techniques have their own limitations. Often,
basic Monte Carlo tools assume that asset returns are uncorrelated
with the assets' own past returns (i.e., not serially correlated
returns) and that correlations with other asset returns in the
portfolio are fixed (i.e., fixed cross-correlations among asset
returns).
Referring now to FIG. 5, there is illustrated a capital markets
model 500, in accordance with an exemplary embodiment of the
present invention. Capital markets model 500 is used to perform
steps 310, 330, and 350 of method 300.
Capital markets model 500 is based on the theoretical notion that
the returns of various asset classes reflect the compensation
investors receive for bearing different types of systematic risk
(or beta). To reasonably forecast the potential distribution of
future asset returns, capital markets model 500 is designed to
identify the primary macroeconomic and financial risk factors and
how they influence asset returns over time.
Using a long span of monthly financial and economic data, capital
markets model 500 estimates a dynamic statistical relationship
between risk factors and asset returns. In an exemplary embodiment,
capital markets model 500 uses regression-based Monte-Carlo
simulation methods to project these relationships in the
future.
The return-forecast portion of capital markets model 500 involves
three fundamental processes, as illustrated in FIG. 5: (1) a core
module 510, (2) an attribution module 520, and (3) a simulation
module 530.
Core module 510 implements a dynamic statistical model of global
macroeconomic and financial risk factors. Its main function is to
generate forecasts of these economic and financial risk factors
over different time horizons. In an exemplary embodiment of capital
markets model 500, core module 510 implements a vector
autoregressive model (VARM). In this embodiment, the VARM measures
the interrelationship of the various risk factors with each other.
This process begins with the VARM estimating relationships (more
specifically, regression "betas") among the system of risk factors
based on historical data. The module can then be used to project
the estimated relationships into the future over any time horizon.
An exemplary time horizon is ten years or longer.
Exemplary risk factors used by core module 510 include the
following:
1. Global equity factors: These risk factors are the core drivers
of asset prices that are linked to the performance of both domestic
and international stock markets.
2. Global fixed income factors: This group of risk factors includes
the primary ones that account for all of the stylized
characteristics of the global term structure of interest rates or
yield curves. The yield curve is considered a leading indicator of
economic activity and inflation expectations. International fixed
income factors capture differences in long-run inflation
expectations between the U.S. bond market and major foreign
governments' bond markets, as well as differences in the expected
rate of real economic growth and monetary policy. It is important
to note that the fixed income factors within core module 510 permit
the generation of a complete term structure of U.S. and
international government bond yields (ranging from one month to 30
years in duration) for every model simulation at every future point
in time.
3. Global economic factors: These risk factors capture current
business conditions, inflation shocks, and realized fluctuations in
the global business cycle. Global economic and financial conditions
are also summarized by commodity markets and foreign exchange
markets indicators. For instance, currency risk factors help to
explain differences in realized returns between U.S. and unhedged
international assets.
A benefit of core module 510 is that it models all of these
exemplary global financial and economic risk factors collectively
and dynamically using a regression-based framework. Consequently,
each of these three risk-factor groups is important to the accuracy
of the forecasts of capital markets model 500.
Attribution module 520 relates the global economic and financial
risk factors to the returns of various asset classes, including
international equities. The main function of attribution module 520
is to "map" the returns of those asset classes to contemporaneous
changes in the core global risk factors. This mapping is based on
observed historical relationships and is estimated using regression
techniques.
For example, attribution module 520 may include the return
differential between unhedged international equities and domestic
equities. Attribution module 520 captures some of the variability
in this return differential based on patterns in certain global
equity risk factors, changes in the shapes of the U.S. and
international yield curves, and fluctuations in the value of the
U.S. dollar, among other factors.
Simulation module 530 constructs scenarios for all risk factors and
asset classes represented in modules 510 and 520. Simulation module
530 creates a distribution of future returns, volatilities, and
correlations 540. In other words, it simulates a broad range of
possible asset-return outcomes (as opposed to a single-point
forecast). In this way, simulation module 530 and, therefore,
capital markets model 500 account for the volatility of asset
return forecasts.
As noted above, in an exemplary embodiment, capital markets model
500 (specifically, simulation module 530) follows a
regression-based Monte Carlo simulation method. In a further
exemplary embodiment, the vector autoregressive model of core
module 510 is combined with a Monte Carlo approach.
As previously discussed, a regression-based Monte Carlo method is
an effective way to incorporate statistical uncertainty into
forecasts. A sensible approach for dealing with statistical
uncertainty is an important piece of any analytical model, since
the model needs to provide investors with an adequate framework to
assess unanticipated risks. In an exemplary embodiment, for each
quarter in the forecast horizon, capital markets model 500
simulates 10,000 scenarios, yielding a complete distribution of
potential future paths for the various risk factors and asset
returns at various forecast horizons.
FIG. 6 illustrates exemplary distributions of outcomes generated by
simulations of capital markets model 500 for selected asset classes
(U.S. intermediate-term bonds and U.S. equities), in accordance
with an exemplary embodiment of the invention. Although not
illustrated in FIG. 6, the outputs of simulations can also be
summarized in reports containing key statistical characteristics of
the simulated data. An array of summary statistics, including
means, medians, and standard deviations, may be tabulated for the
various asset-class returns at various forecast horizons.
The execution of model 500 can be divided into two phases. A first
phase includes the three modules as previously described: core
module 510, attribution module 520, and simulation module 530. The
final outcome of this first phase is the distributions of returns
and volatilities 540 at the level of each asset class. The second
phase consists of combining the asset classes' simulations to
create a full set of potential investment portfolios to be
considered. Thus, the simulation output from model 500 forms the
basis for further analysis and simulations at the portfolio level.
Outcomes are combined with exemplary objectives, risk tolerance,
and investment horizon of the fund.
It should be understood that some or all of the steps of methods
200 and 300 and some or all of the functionality (modules) of
capital markets model 500 may be carried out by or with the
assistance of a computer, including but not limited to automated
processes for the following: (i) all or any portion of the fund
management processes; (ii) issuing, buying, and selling of shares
and underlying securities; (iii) receiving and transmitting
transfers to and from financial institutions for the purchase or
shares or the distribution of periodic payments to shareholders;
(iv) calculating the amount of periodic distributions; (v)
computerized accounting; (vi) computerized receipt and storage of
shareholder data; (vii) computerized reporting to shareholders; and
(viii) other computerized or automated functions comprised within
the management, distribution, servicing, and other activities in
connection with fund 100 and model 500. It should also be
understood that the programming techniques necessary to automate
such steps and modules by computer are well known in the art.
Although the invention is illustrated and described herein with
reference to specific embodiments, the invention is not intended to
be limited to the details shown. Rather, various modifications may
be made in the details within the scope and range of equivalents of
the claims and without departing from the invention.
* * * * *
References